Trawnegan Gall on Delaware Statutory Trusts: A Primer on Real Estate Portfolio Diversification in 1031 Exchanges

Trawnegan Gall on Delaware Statutory Trusts: A Primer on Real Estate Portfolio Diversification in 1031 Exchanges
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The Delaware Statutory Trust (DST) serves as a beacon for many 1031 exchangers, navigating the waters of real estate investments. Designed with meticulous precision, this investment structure promises a passive, institutional quality alternative for 1031 exchangers, particularly those eyeing retirement and a departure from active real estate management.

The Rise of DSTs in Real Estate

A DST caters to a growing segment of investors who commenced their journey in real estate with small rental properties. Although direct ownership and management of real estate offer profitable avenues, age and the desire for more passive ventures while still availing of the benefits of 1031 exchange often push owners to seek alternatives. DSTs offer a viable alternative meeting these requirements.

DSTs streamline the acquisition process. The trust, with the sponsor as its trustee, holds the deed, eliminating the need for investor votes for property-related decisions. The emphasis thus shifts to the credibility of the sponsor. With typical DST properties priced between $25-100 million, investors gain access to premium, professionally managed real estate assets, ranging from apartment complexes to single tenant net leased properties.

The Mechanism and Advantages of DSTs

Operating under the aegis of Delaware law, a DST serves dual roles: it meets the requirements for 1031 exchanges and offers a path to retirement from active real estate management. The trust structure is intricately designed to satisfy IRS criteria for “like-kind” property, ensuring that investors continue to enjoy the substantial tax benefits.

The financial framework of DSTs provides projected monthly income distributions from property operations. On the property’s eventual sale, the investor typically re-engages in a 1031 exchange, transitioning into a new DST. This seamless “roll-over” process can often be concluded in mere hours.

Risks, Rewards, and the Informed Investor

While DSTs offer tantalizing benefits, potential investors must also understand the associated risks. Like any real estate venture, DST investments come with their share of market-related uncertainties. Tenant dynamics, mortgage financing, and rental rates play significant roles in the eventual outcomes.

However, perhaps the most pronounced risk in DST investments lies in its passive nature. The investor, distanced from active management, places significant trust in the DST structure and sponsor. Such a passive stance necessitates a detailed understanding of the trust structure, the security aspects, and a thorough evaluation of potential returns versus risks.

The lure of deferring tax liabilities through a 1031 exchange remains a predominant reason for investors to explore DSTs. An impressive 90%+ of investment dollars channeled into DSTs arise from 1031 exchanges. Therefore, while transitioning from one real estate investment to another may not significantly alter the risk profile, it’s imperative to analyze the DST’s merit, considering all potential rewards and pitfalls.

Contrastingly, tenant-in-common (TIC) interests, another option for replacement properties in a 1031 exchange, pose some significant challenges. Notably, even while the sponsor will take the lead, TIC ownership can necessitate coordination among up to 35 owners. Unanimous approvals for significant decisions become a cumbersome affair. Further, the need for individual lender vetting adds to the intricacies. Though TIC investments can be an excellent option for larger investors with minimum investment amounts of $1 million and up, these challenges have led to the gradual decline of TICs, making room for the increasingly popular DSTs.

The Role of Securitized Real Estate in DST Investments

Securitized real estate, by design, offers investors a passive stake in a property marketed as a security asset. Stringent securities regulations increase transparency and more extensive due diligence, paving the way for better informed decisions. DSTs, among the array of securitized real estate structures, stand out for their viability as “like-kind” property for 1031 exchanges.

Investors get the best of both worlds: the advantages of a security and a stake in institutional quality real estate. While these investments do carry inherent risks related to real estate dynamics, the securitized nature provides added layers of scrutiny, due diligence, and professional management.

Trawnegan Gall: A Specialist in DST Investments

Located in the Dallas, Texas office of Cornerstone Real Estate Investment Services, Trawnegan Gall has carved a niche in the realm of DST investments. With over $400 million of brokered equity in real estate securities and co-authorship of Modern Real Estate Investing, the Delaware Statutory Trust, Mr. Gall’s expertise stands out and helps navigate the intricacies of DSTs, securitized real estate and 1031 exchange.

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